Friday, November 5, 2010

Could there be a silver lining to quantitative easing/currency depreciation of the US dollar? Previous posts here, and much of elsewhere, have focused on the destructive effects of the easing. But my question now is, could it actually have a positive effect?

In my thinking, it all depends on whether it succeeds in effecting one of the lesser talked about objectives that the global economy right now – realigning and revaluing of currency values, commensurate to the growth rates of their respective economies.

Right now, global imbalances persist because certain countries choose to peg their currencies to the US dollar. So if an overvalued US dollar results in a trade deficit to the US, the self-correcting mechanism of an appreciating currency does not result. The continuous peg of exporting countries on the dollar keeps it from doing so. So the US continues incurring a trade deficit while the pegged countries continue having their surplus.

What quantitative easing would do, more than causing the hoped for but largely improbable reflation in the US economy, is to cause this inflation elsewhere, mainly due to shifts in hot money flows and the carry trade, particularly to the countries that peg themselves to the US dollar.

It is inescapable. If they choose to keep the peg, the more inflation they cause on themselves, because their trade surplus results in a continuous influx of currency into their economy, but also because their peg forces them to allow in more of the US dollars being printed. The more the Fed eases, the more dollars these pegged currencies have to sterilize, and hence, the more they too, end up loosening monetarily. A loose monetary policy is the last thing a surplus country with a booming economy should be doing.

A silver lining that might result is an overall increase in salaries of the surplus nation’s local workers, to compensate for the increasing costs of goods domestically. This would lead to more equalization of living standards globally. Done the right way, and in the right areas, and it would no longer matter which country you go to, to hire a mechanic, a barber, or have your taxes done. They will all congregate to one global standard price.

On the US side, this means a return of a lot of manufacturing capacity, as their local manufacturing wages become more competitive vis-à-vis the rest of the world. As for the rest of the world, i.e. the emerging markets, their populace’s rising income should make their local economies more readier to accommodate higher value-added services and businesses that currently are only viable in the US.

Could we see the rise of an equal to Wall Street in Shanghai or Melbourne? Or an equal to Silicon Valley and Hollywood in Mumbai? What about an automotive design center considered a peer to Detroit situated in Bangkok? Or a garment design center similar to New York, but located in Jakarta. Could this actually happen, or can this be nothing more than a pipe dream for the emerging economies?

My guess is that as things currently stand, a fast-rising inflation will crush these economies. Inflation will end up killing the people’s real income, and hence, their purchasing power, and lead to over-all depression in the economy. Which is why they are taking steps to prevent this from happening. They would rather have capital controls, and likely, would rather give up the peg than allow hyperinflation to kill their economies.

But what should be done, such that the alternative scenario could happen? What is needed, so that emerging economies can take this opportunity to grow and nurture viable higher value-added service economies that could be considered equal level alternatives to those in the US? Previous posts here would provide some ideas.

Not all emerging economies are as big as the BRIC nations, hence not everyone has the requisite economies of scale to nurture high end service-intensive industries that can compete side by side with the US. So they need to set aside any local rivalries, and start thinking about creating regional trading blocs.

Higher end service industries need a lot of higher-end personnel. Hence, they need to open up and allow unfettered migration of experts into their local economies. As repeatedly recommended, like a broken record, on this site and elsewhere, they need to develop a healthy thriving local consumer base. Do so, and perhaps, even higher-end personnel they have already lost to the developed economies will start coming back to help jumpstart the transition to higher end. They need to put special focus on and promote small business, the largest employer in the aggregate of the economy. Since a thriving and healthy local consumer populace will start eating more and demanding more, they need to reinvest in agriculture.

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"Conventional approaches, unconventional conclusions" on the global finance and economic issues of the day. Rogue Econ has been a banker and financial consultant in several countries. Welcome to my blog.